Employer contributions - how much and who for?

In the last week I have come across two separate enquiries about employer pension contributions – each at the opposite end of the age spectrum.

The first was in respect of an employee over the age of 75, the second for a 14-year-old. The question in both cases was whether we could accept the contribution, and at what level.

There are no age limits for accepting employer contributions, and legally children can work part-time from the age of 13. So, provided they are genuinely an employee, then both contributions can be accepted.

The question of the level of contribution that can be paid is more complex.

Employer contributions are paid gross, and it is the employer, not the pension scheme that claims tax relief.

The basic rule for any employer contribution is that it must meet the “wholly and exclusively” rule to qualify for tax relief. There are no restrictions on the level of the contribution that can qualify for tax relief, provided it is for genuine business purposes. Unlike personal contributions, the amount of tax relief is not restricted by salary, and it is not uncommon for directors especially to have employer contributions that exceed salary. If the local inspector of taxes were to query a contribution, they would look at the total remuneration package for the individual (salary + employer contribution + other benefits) and ask if they are worth that value to the business. If the answer is yes, then the contribution should be allowable in full.

Whilst the employer’s tax relief is theoretically unlimited, the individual is subject to the annual allowance. If the employee’s total contributions (personal and employer) across all schemes exceeds their annual allowance, then they will have a tax charge to pay. When it is an employer contribution that tips them over the limit then they may still want to receive the contribution and pay the charge if there is no alternative remuneration offered.

The query relating to the 75-year-old was based solely on their age. If they are still working then there is no issue with them continuing to receive employer contributions (only personal contributions are no longer eligible for tax relief).

The 14-year-old works part-time on a salary of £2,000/year. The question was whether an employer contribution of £40,000 could be made. The same principle applies as above – is the “wholly and exclusively” rule met? My first reaction was that it is unlikely. It is worth noting, however, that HMRC states that generally pension contributions are likely to be allowable, and it is relatively rare for them to have to consider whether there is a non-trade purpose for the employer’s decision to make the contribution.

What was important in this scenario – and this will come as no surprise I’m sure – was that the child in question was related to the controlling director.

When we come to contributions paid in respect of controlling directors/business owners or an employee who is a relative or close friend, then there are extra considerations. In these scenarios there may be a non-trade incentive for the employer to make a larger-than-otherwise contribution. The general rule is that HMRC will allow the contribution for tax relief where the total remuneration package for the connected party is comparable to that paid for unconnected employees.

In the case of the 14-year-old it is unlikely that there is another employee doing a similar level of work to compare them to. However, if there are other employees who are doing substantially more work, adding more value to the business, and whose total remuneration is not substantially higher than the child’s this is likely to set off alarm bells. Even in cases where there may only be the directors and the child in the business, a large contribution may be looked at in more detail.

The other point that crossed my mind is – why do an employer contribution at all? Usually, employer contributions are more effective than personal contributions due to the National Insurance (NI) saving. But under-16s don’t pay NI, and neither does their employer. If, for example, £10,000 salary was paid instead, then this is within the personal allowance so no Income Tax would be due. If £8,000 were paid as a personal contribution, £2,000 tax relief would be awarded under relief at source, so the final position would be £10,000 in the pension and £2,000 in their bank account.

Of course, this would still be dependent on the employee being worth £10,000 to the business. The point is that the rules on what is an acceptable level of remuneration for family members for it to be a tax-deductible business expense will be the same regardless of whether it is in the form of salary or pension contribution.

If HMRC decides there are non-trade reasons for the remuneration, then they may disallow some of the deduction for tax-relief. It is important to note that if this occurs in relation to an employer contribution, this is not grounds for a refund and the contribution would need to remain in the scheme.

This article was previously published by Professional Adviser